Electronics Retail: Investing Essentials

Your guide to one of the fastest-changing segments in the retail industry.

One of the great revolutions in retail over the past decade has taken place in electronics retail. Consumers once had to travel to brick-and-mortar stores for the latest electronics, and most came with a cord that tethered users to an outlet. But those days changed as the wireless revolution took hold and online retail began to replace electronics stores. That has created a big shift in the way consumers shop, as well as how investors should look at this industry.

Electronics retailers like Best Buy used to dominate the market, but sales have waned in recent years and they've turned to services like Geek Squad to stay relevant with customers.

What is electronics retail?

Electronics retail is the sale of electronics products to consumers. That has come to encompass everything from computers to smart watches to wireless devices we use every day.

In many cases, there are two components to electronics retail sales. There's the purchase of an electronic device such as a smartphone or tablet, and then there are service offerings such as wireless or installation that are often tied to devices. The combination of devices and services can lower the initial price of electronic devices through subsidies while increasing profits to companies through long-term contracts.

For example, the cost of an iPhone 5 is currently $549.99 retail, but the price with a contract is $99.99 from Verizon Wireless. Retailers like Best Buy and RadioShack will also offer similar pricing models and get a higher price from the wireless service company due to the subsidy they provide. The symbiotic relationship between electronics retailers and services like wireless are lucrative; Best Buy generated 40% of its sales from computing and mobile phones last year, while an additional 5% came from services like Geek Squad, home theater installation, and warranties.

There are a number of channels through which electronics retail sales occur. Traditional brick-and-mortar stores can offer a wide variety of products and were the dominant force in the industry until the 2000s. More recently, online retailers have taken a significant share of sales because they can offer lower prices and valuable user reviews. According to data from the Census Bureau and market research company eMarketer, online retail as a whole grew at a 16.2% compound rate from Q4 2008 to Q4 2013 and online electronics retail grew at a similar rate. In some cases the brick-and-mortar and online retail channels will overlap when brick-and-mortar stores also sell goods online.

An emerging channel is direct-from-manufacturerretail, both brick-and-mortar and online. Apple Stores, which now generate more sales per square foot than any other store in the world, are a prime example of this trend. The model has worked for large electronics makers with a large brand presence and allows sales staff to educate consumers on the functionality of their devices.

Online retailers like Amazon.com have clearly taken share from brick-and-mortar competitors.

How big is electronics retail?

In 2014, U.S. consumer electronics industry revenue is expected to grow 2.4% to a record high of $208 billion, according to the Consumer Electronics Association. The industry grew at a compound rate of 4.7% from 2009 to 2014. New categories of products including wireless speakers, convertible PCs, and health-and-fitness devices have become the industry's top growth drivers.

The electronics retail market is dominated by a small number of players. According to consulting company Cognizant, Best Buy, Apple, and Wal-Mart control 60% of the market share among brick-and-mortar retailers. Online, Amazon.com is the biggest player, with $30 billion in "electronics and other" sales during 2013.

How does electronics retail work?

The huge market size provides a tremendous opportunity for retailers, but the market has also grown into new sales channels that have changed the former status quo. Electronics were once found primarily in brick-and-mortar locations such as Best Buy, Circuit City, and RadioShack, but they're now also found online and in branded stores operated directly by manufacturers. In that respect, the distance between electronics manufacturing and consumers has shrunk, but that has also led to major changes in the retail industry.

Brick-and-mortar retailers have struggled to keep up with the online retail revolution, with Circuit City succumbing to bankruptcy and RadioShack struggling to survive. Best Buy has gone through a number of strategic changes, particularly focusing on smartphone and tablet sales that are tied to service contracts with wireless providers and offering services from Geek Squad and Magnolia to service and install complex electronics systems.

The latest trend is for brands to open up their own retail stores, highlighted by Apple, which generates more sales per square foot than any retailer in the world.

It's important for investors to understand what competitive advantages electronics retailers do and don't have. Products are an important part of a retailer's offering, but as Circuit City showed us, selection alone won't keep a company alive. If selection is all they offer, then they're competing on price, and that's a recipe for lower margins and potential disaster.

Successful electronics retailers are now selling their own goods, moving online, or offerings services such as wireless plans, product installation, and ongoing maintenance. It's no longer good enough to make a sale and say goodbye. Good electronics retailers create a long-term relationship that keeps the money coming in quarter after quarter.

What are the drivers of electronics retail?

The biggest driver of growth and profit in electronics retail is innovation, which is something retailers don't control. That leaves them susceptible to swings in demand from quarter to quarter as new devices are introduced into the market.

But these new devices are also what keeps consumers coming back to electronics retailers. Smartphones, tablets, and other new gadgets drove the industry's growth over the last decade, and the next decade will be dominated by new product categories such as health-and-fitness wearables, wireless and connected devices, and 3-D printing.

As these categories grow, they'll define how we look at electronics retail. This is a fast-evolving industry and investors need to stay nimble as the market shifts. The winners of today aren't likely to be the winners of tomorrow, which we've seen in electronics retail time and time again.